Operation of Law Defined
The phrase "operation of law" is frequently used in real estate law but it is often unclear to real estate agents and even attorneys exactly what it means. When used, it is often used in the context of a contract clause that calls for a termination or other remedy upon the operation of law. A common example of the operation of law termination occurs when taxes are not paid on property. Taxes become a lien on the property upon assessment and if not paid the property will be sold in a tax sale. The deed reflecting the transfer will convey good title to the purchaser at the tax sale by operation of law. In other words, there will be no deed from the owner of the property to the purchaser at the tax sale. The law terminates the owner’s fee simple interest in the property.
Another common example in the context of condominium and homeowner associations is a clause in the association’s declarations that provides for termination of membership and loss of the right to use the common property and facilities upon a delinquency in assessments . As in the tax sale context, the law functions to terminate the person’s status as a member of the association and does so as soon as the condition for termination is satisfied which, in this example, is a delinquency in assessments. An owner, for example, who has once lost his right to use the common elements and facilities due to nonpayment of assessments does not automatically regain that right when the delinquency is resolved, rather a separate action to reinstatement must be undertaken.
The phrase "by operation of law" extends into areas other than the examples mentioned above. In the context of real estate and more specifically in the context of real estate contracts, statue or contract will provide the law under which a contract is terminated. Note however that some times a contract might also call for the other party’s voluntary waiver or other action as a condition to the operation of the law. In that instance, that condition would need to be satisfied before operation of law would terminate the contract.
Some Typical Real Property Situations That Are Subject to Operation of Law
The "operation of law" is a fundamental concept in real property law, but it is far less predictable and at times, less intuitive than one might think. What if one half of a married couple wants to buy a property or sell a home, but the other half refuses? Or, what if a tenant wants out of a lease against the wishes of the landlord? And what about foreclosure?
In the scenarios below, the operation of law will come into play:
Inheritance
Upon the death of a spouse or parent, real property owned by the decedent typically goes through probate proceedings for the purposes of determining the beneficiary of the property and the validity of any Will. Depending on the manner in which that property was dedicated in title, the property sometimes does not go through the probate process. For instance, property that is owned as "tenancy by the entirety" between a husband and a wife upon the death of one, will vest in the remaining tenant by operation of law giving rise to a "conveyance" or a transfer of title without the requirement or necessity of any action being taken by either of the spouses. Similarly, bank accounts held by spouses as joint tenants are distributed or distributed by operation of law, and not by any action of either spouse.
Divorce
Following the divorce of a husband and wife where they both owned real property as tenants by the entirety, the property will immediately vest in one-half of a spouse’s former interest in the property in favor of the non-divorcing spouse free and clear of all of the rights of the other spouse. Thus for example, if husband and wife each own one half interest in a parcel of real property as tenants by the entirety, on divorce, the property will vest in the former wife (as surviving tenant by the entirety) one-half her interest in the property. The remaining one half interest of the husband will vest in the wife one-half its value.
Foreclosure
Upon foreclosure of a residential or commercial mortgage loan, the foreclosing creditor of the property will have the right to foreclose on the property secured by that mortgage and any other lienholders will have an interest in the equity of redemption to the extent of their respective interests in the property. This means that unless a written waiver is obtained in the foreclosure process, all property owners will have their existing rights to redeem vested in them by statute as of the foreclosure judgment date. Thus, even though a home is in default on its mortgage payments, and notice of foreclosure has been given, it is still possible to sell the property by a power of sale provided the transaction is consummated by the foreclosure judgment date.
How Title Can Be Transferred
Title transfers can also occur by operation of law. The most common involuntary transfer of title by operation of law occurs when a person dies. The effect of a person’s death to the existing property interests of that person is determined by the decedent’s will (if any), by beneficiary designation, or by operation of law, as in the case of joint tenancies with rights of survivorship or tenancies by the entirety. State statutes may recognize the validity or enforceability of various beneficiary designations that effect a change in the legal title to property held by the deceased.
The effect of a court order on title operations will depend on the facts and the legal authority under which the order arose. A levy on a property pursuant to a judgment, for example, would affect title in favor of the claimant. A sale of property by the sheriff in satisfaction of a judgment may have similar effect. Courts may also order the transfer of title in the course of equitable actions and receiverships. Although some conveyances are governed by different rules, in general, the operation of law transfers are valid until they are reformed or set aside by operation of a court (or other) order or statute.
Legal Consequences for Property Owners
The "operation of law" by its very nature does not call upon the owner to make such a highly-priced decision, or to expend resources, in order to take a position. Choices have already been made on the owner’s behalf. Nor do such occurrences allow time for the owner to assess the pros and cons of changing circumstances. That is the downside of the speed and immediacy conveyed by operation of law. The upside is that change has already been made in most cases, and no further expenditure of time or money is needed to achieve the result. The decision belongs to another, who had the burden of expending resources and making a decision as to the way forward. Except that the owner did not participate in the debate, and particularly in the case of a mortgage or economic lien, the decision may be high-stakes.
Owners may be surprised to learn that they remain legally responsible for the property after an ownership change occurs under the operation of law, and that it could be a very long time before the transaction might be set aside by appropriate authorities, if ever. Thus, instead of being relieved of the burden of paying property taxes, the owner may find the obligation more onerous than ever as tax authorities may assess the property at the highest recovery prices possible, and go to the limits of the law to impose tax penalties. Subcontractors will remain free to assert liens on the property, and the obligation to pay taxes comes from owning the land, not developing it.
To illustrate how a high-stakes decision can be made on and the consequences fall on the owner when ownership changes under the operation of law, picture a high-rise building downtown . The builder pays for the land and puts up a beautiful steel-and-glass structure, but does not have the funds for development of the interior. The builder secures a mortgage loan from a bank, who loans the developer money, taking as security the mortgage on the downtown site. Both are oblivious that the developer has been negligent in filing the required condominium declaration for the building’s interior. The developer goes bankrupt, and when the bank goes to foreclosure to acquire the building, there is no declaration for the high-rise building. So the banks acquires the property subject to the highest unit-of-measure legal method for at least two reasons: 1) units are traditionally valued separately by square footage and 2) no declaration has been recorded. Now the condo association must pay the taxes because it is now the owner of record. And it must pay subcontractors, because it is the owner of record. No relief can be had from the shareholders, who have received no bills for the project because it was debt-funded. The association will have to fund insurance premiums as well, to protect its "interest," and the premium is now payable monthly because no lump-sum insurance premium payment was made, as it would have been if a declaration created an O&M. The bank has no obligation to pay taxes, assessments, dues or fees, and it has no interest in such matters. The developer has no obligation to pay taxes because it is bankrupt, and so is the bond that would have paid off subcontractors. Subcontractors can recover from the bank, but not the developer, and not the association or any of the shareholders who benefitted from their services. Everyone shelters behind the limited liability corporations they form to protect personal assets, and the condo project is going down in flames.
How to Address the Legal Change
While the occurrence of changes in the operation of law is rarely avoided, it is not impossible to anticipate or mitigate the impact of such changes on real estate transactions. Those negotiating agreements and structuring deals should stay informed and vigilant to identify issues as they arise so as to be able to address the same promptly. Doing so will often save both time and money. Key ways to do this are: (i) staying abreast of proposed legislation that may impact real estate transactions, and (ii) closely monitoring ongoing litigation that may impact existing law.
Most states have websites that give access to the full text of all pending proposed legislation. Such websites provide a year-by-year legislative history of each state, which is easily reviewed to identify prior versions of the proposed legislation. Often, this allows the industry to identify an adverse legislative initiative that had hidden in plain sight. A good example is the recent legislation recently passed in New Jersey to establish a right of first refusal in favor of non-profit organizations with respect to the sale of any multi-family housing unit consisting of four or more units. As written, the proposed legislation would have had a devastating impact on New Jersey investment real estate, as the law, if enacted into law, would have required the same terms and conditions of a bona fide third-party contract to be offered to the association of tenants who reside in the multi-family property. This was particularly problematic because it did not provide any mechanism for an expedited review of the offer or the board’s decision in most situations. After a substantial lobbying effort by members of the industry, the version of the law that was passed was amended to only require a written notice 20 days prior to the closing of any anticipated sale and an obligation to provide the price and major terms of any sale within five days of receiving a bona fide offer from a third-party purchaser. This is consistent with the customary due diligence involved in any real estate transaction, as a closing typically will not occur without the prior review of the transaction documents by the buyer.
Similarly, almost all states publish websites that track ongoing litigation that will impact existing law. By staying informed about the progress of a pending litigation, practitioners can make a more informed decision about whether to invest time and money in a similar action and what strategy to adopt in pursuing a particular outcome.
Examples and Applications
When developers execute an agreement with a municipality for the purchase of land, it is not unusual for the developer to think that the municipal agreement is the final say on what they can do with the property. This is not always the case. In some circumstances, particularly when there is more than one level of government involved, the development approval process can be quite intricate and can include several layers of approvals.
The recent Ontario Superior Court decision in Agora Development Corporation v. Toronto District School Board, 2015 ONSC 514 is a perfect example of a complicated real estate transaction in which the approvals required involve aspects from both the municipal and provincial levels of government.
In this case, the planning involved zoning by-law compliance as well as approval from the Technical Standards and Safety Authority (the "TSSA"). The plaintiff, Agora Development Corporation ("Agora") had signed an agreement with the Toronto District School Board (the "School Board") to purchase a parcel of land (the "Land") that had been surplus to the School Board’s needs. The Land was subject to a number of easements held by Hydro One, Enbridge and the TTC. The TSSA had approved two easements in favour of TSSA on the Land and a third easement was requested from Enbridge in order to comply with the conventional setback requirement of 30 meters. A formal subdivision of the Land was required in order to discharge the original easements and replace them with those in favour of the TSSA, Hydro One, Enbridge and the TTC.
Agora’s plan was to build a 59 storey residential condominium tower on the Land and the only feasible way to do this was to locate the tower in close proximity to the Enbridge easement. Local bylaws require a 15 meter separation between a building and a pipeline easement, which allows a 44 storey building on the Land (this is the minimum number of stories required to make such a building economically viable). However, the TSSA requires a 30 meter separation. Agora sought to locate the core of the building at 29 meters from the easement. They sought a set back agreement with Enbridge . In July 2010, Agora presented its request to the Enbridge Project Coordination Committee, which consisted of: the City of Toronto, the Ontario Ministry of Transportation, the Ministry of Energy, Hydro One and Toronto Hydro.
The Enbridge committee approved a 21 meter separation together with a mitigation plan proposed to Agora, which involved annual inspections and a semi-annual monitoring report. Agora then entered into an agreement with Enbridge that contemplated an easement with a 31 meter setback, however, the agreement also had a "Back-to-Back Indemnity" clause, meaning that if a wholly owned subsidiary of Agora were to be the registered owner of the new development, the easement agreement would not apply. Agora then established a new company called 2211 Yonge Development Inc.("2211 Yonge"), apparently for the purpose of circumvention of the Back-to-Back Indemnity.
Once Agora had signed the easement agreement with Enbridge, Agora began the subdivision process and eventually received approvals from the City of Toronto, the TSSA, Hydro One and the TTC for the easement transaction and the Lot for the new building. Agora then attempted to register the easement agreement against the title and reference plan, however, 2211 Yonge was the registered owner of the Lot and the TSSA disputed that it was bound by the easement agreement.
In April 2014 Agora brought a motion against the TSSA for a declaration that the easement agreements bind the TSSA. In July 2014, a deputy judge of the Ontario Superior Court ordered the parties to enter into binding arbitration in accordance with the applicable provisions of the Ontario Arbitration Act, 1991, SO 1991, c 17, instead of granting the order in Agora’s favour.
It is clear in this case that there were some conflicting mandates from the various people who were required to approve the agreement for the subdivision of the Land and transfer of the easements. The TSSA’s mandate is the safety of fuel pipelines which kept them from agreeing to a pledge of safety by Enbridge. IO’s and Hydro’s mandates were the protection of the lands they serve with the new easements. The balance of the competing interests could only be addressed at arbitration.